Netflix : How a Subscription Price Cut Boosted Free Cash Flow!

Lights, camera, cash flow! Has Netflix orchestrated a strategic financial facelift by cutting back on its starring role in the Netflix debt drama, and is now gliding towards a blockbuster finale that has investors applauding?

Netflix has become an integral part of our lives. From “Stranger Things” to “The Crown”, Netflix’s original content keeps us hooked, episode after episode.

But did you know that behind the scenes, there’s another kind of drama unfolding—one that involves managing billions of dollars, financial risks, and strategic moves detailed in the Netflix annual report?

260 million. That’s the number of subscribers Netflix has amassed since 2013.

This success, however, comes with a significant price tag. In less than a decade, Netflix has borrowed more than $16 billion to spur growth. Even with all that's going on, the company has kept a friendly Netflix balance sheet, keeping investors happy while also chasing further growth.

So, What Makes Netflix Financially Click in 2024?

That’s exactly what we’re here to do with this article: take a tour through the health of Netflix’s treasury, the driving force behind its growth engine.

To be more specific, we’ve analyzed Netflix’s financial data from 2019 to 2023. We’ve examined:

1. The lifeblood of the business, its Free Cash Flow (FCF),
2. Whether the Borrowing increases or decreases to its Sales Revenue,
3. The critical financial yardsticks of liquidity and solvency: Current and Netflix Debt-to-Equity Ratios.

To provide a comprehensive understanding of Netflix’s position, we’ve compared its performance against other powerhouses in the Entertainment and Mass Media industry, namely Comcast, Walt Disney, and Paramount Pictures. Together, these four entities are the world’s four most valuable media companies.

Our first point of analysis is Netflix’s Free Cash Flow (FCF), a key indicator that will shed light on the comparison between its Net Operating Cash Flow and Capital Expenditure.

Netflix's 5-Year Free Cash Flow: $1.44 Billion Average

A critical indicator of financial stability, FCF reveals the amount of cash left after a company has paid its expenses. Over the past five years, Netflix’s average FCF has been $1.44 billion, trailing the industry average of $5.33 billion.

At first glance, this might suggest a lag in Netflix’s cash-generating capabilities. However, a year-by-year analysis reveals a more nuanced picture.

In 2019, Netflix’s FCF was in the red at -$3.14 billion. By 2023, it had made a dramatic turnaround to $6.93 billion. This remarkable shift can be credited to a substantial rise in Net Operating Cash Flow, while Capital Expenditure remained relatively stagnant.

But, what’s driving this rise? Let’s explore:

Factors Leading to an Increase in Net Operating Cash Flow

Three initiatives have led the net operating cash flow to rise:

1. Subscription price hike: Netflix has raised its subscription prices in the US, UK, and France, positively impacting its net operating cash flow.
2. A successful crackdown on password sharing: Netflix’s crackdown on password sharing led to the addition of 9 million new subscribers globally, with revenue reaching $8.5 billion in the third quarter of 2023 — an 8% increase from 2022 and surpassing expectations thanks to the significant influx of new members.
3. The introduction of Ads plan: In November 2022, Netflix introduced an Ads plan, offering price-conscious users a more affordable option for streaming. The Ads plan now represents 40% of all new Netflix sign-ups in markets where it’s available.

Having examined Netflix’s Free Cash Flow (FCF) trends, let’s now explore its debt trends. For many years, debt was a significant source of capital that was driving the company’s growth.

Netflix's Debt Decreased by 8.28% Over the Past Four Years

Netflix’s financial trajectory over the past five years presents a fascinating case study of strategic debt management.

In 2020, Netflix reached its highest level of Netflix debt at $18.5 billion. This money was borrowed to support its growth plans and to finance its operational expenses, including the creation of entertainment content, salaries, rent, and promotional activities.

However, by 2023, this figure had been trimmed to $16.9 billion, suggesting a tactical shift away from debt-driven growth. What’s particularly interesting is that, in 2023, the total debt has been reduced to $16.97 billion from $18.5 billion in 2020—a decrease of 8.28%.

This evolution, as showcased in the Netflix annual report, combined with the steady increase in sales revenue—from $27 billion in 2019 to $29.65 billion in 2023—paints a picture of a company that’s not just growing but also becoming more financially sustainable.

In short, Netflix’s evolving debt management suggests a strategic recalibration. What’s likely to trigger this shift? Let’s dig deep.

A Shift in Business Strategy! Saying “No” to Debt-driven Growth

1. Financing Pivot: In the year 2021, Netflix made a pivotal and strategic decision to cease financing its operations through the accumulation of debt. This decision was driven by the realization that the company no longer saw the need for such a financing model. The link to this significant change in financial strategy was announced in a New York Times article.
2. Debt Reduction: This strategic shift in financial management led to a steady and noticeable decrease in the amount of debt that was outstanding in the company’s books. Over a period of three years, from 2021 to 2023, there was a decline in long-term debt by 5.5%.

But, why did Netflix accumulate such significant debt initially?

Single word answer: growth.

The content industry is capital-intensive. For example, a series like “Stranger Things”, which is fully financed and owned by Netflix, has a production cost of up to $8 million for each episode. Considering the hundreds of hours of original content that Netflix creates every year, the cost starts to add up significantly.

This led to a situation known as “negative Free Cash Flow” up until 2019, where the company was spending more than it was earning. Netflix bridged this gap by increasing its borrowing.

With this in mind, let’s examine Netflix’s liquidity and solvency ratios to understand its capacity to repay its short and long-term debt, and explore any strategies or events that have prompted Netflix to invest, divest, or curtail growth.

Examining Netflix's Current & Debt-to-Equity Ratio

Netflix’s Exhibits Strong Financial Health for Short-term Debt Coverage

Netflix’s current ratio, which signifies a company’s ability to cover its short-term debts, fluctuated between 0.9 and 1.25 from 2019 to 2023. Despite this mild inconsistency, the ratio’s average of 1.078 over the five years remained remarkably close to the industry average of 1.079.

However, the Netflix debt-to-equity ratio tells an even more compelling story. This ratio experienced a consistent decrease—from 1.97 in 2019 to 0.71 in 2023, as highlighted in the latest Netflix balance sheet. This decrease signals a movement towards a less leveraged and more equity-financed structure.

But let’s dig a bit deeper into ‘the why’ of this inconsistency:

In 2019 and 2021, Netflix’s current ratio fell below the ideal value. This decrease can be attributed to current liabilities surpassing current assets.

Current Ratio= (Current Liabilities/Current Assets)

Primary reason? Due to aggressive content and production financing and an expansion in the gaming vertical.

1. Netflix’s 2019 shareholder letter (published on 20-Jan-2020) states the proof of its investments in emerging content categories, “K-content is also popular globally, and we’re investing heavily in Korean stories”.
2. And the 2021 shareholder letter (published on 22-Jan-2022) mentions its plan to expand in the gaming vertical. It states, “In November we debuted our mobile games experience globally on Android and iOS”. The letter further states, “In 2022, we’ll expand our portfolio of games across both casual and core gaming genres as we continue to program a breadth of game types to learn what our members enjoy most”.

Netflix’s Debt-to-Equity Ratio: A Decreasing Trend

The debt-to-equity ratio gauges a company’s financial leverage by comparing its total liabilities to its shareholder equity. For Netflix, this ratio experienced a consistent decrease—from 1.97 in 2019 to 0.71 in 2023, indicating a movement towards a less leveraged and more equity-financed structure.

1. Even though Netflix’s ratio is slightly above the corrected industry average of 1.78, the steady decrease demonstrates a deliberate strategic decision to lessen financial risk and dependence on debt.
2. A deeper analysis reveals that, in 2019, Netflix’s shareholder equity (total assets – total liabilities) was at $7.5 billion, and by 2023 it had grown to $20.5 billion. This is due to a steady increase in its total assets — from $34 billion in 2019 to $50 billion in 2023 — while total liabilities have remained relatively constant over the years. Once again, the reason is massive investments in financing high-quality content.

What the Future holds for Netflix?

Netflix’s investments in content, while considerable, have a silver lining. It is building a competitive moat aimed at attracting more subscribers.

Moreover, major initiatives undertaken by leadership to increase net operating cash flow are yielding results. These efforts have led to a staggering 1751% increase in net operating cash flow – from $393 million in 2021 to $7.2 billion in 2023.

Looking ahead, Netflix’s financial strategies, as outlined in the Netflix annual report, indicate a focus on building long-term value. By reducing its reliance on debt and bolstering its cash flows, Netflix is paving the way for sustained success in the competitive streaming industry.

As Netflix continues to navigate the financial landscape of the streaming industry, it will be interesting to watch how these financial strategies further fuel its growth in the coming years.

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